In this interview with Mahesh Patil, Co-CIO (Equity), Aditya Birla Sun Life Mutual Fund discusses shrinking alpha in active funds, the delayed earnings recovery at India Inc and more.
What's your take on the long-delayed earnings recovery at India Inc?
Over the past 18 months, the Indian economy and corporates have faced a number of issues due to which the GDP growth slowed down from 8 per cent YoY in Q1 FY19 to 5 per cent YoY in Q1 FY20. Naturally, this led to a slowdown in corporate earnings and earnings estimates were downgraded. However, on the positive side, the government has announced a number of measures designed to release liquidity in the system and get the credit cycle back on track. The reduction in the corporate tax rate should release equity capital in the corporate ecosystem, encourage the investment cycle and help in attracting FDI.
Both GDP growth and earnings growth have likely bottomed out and we should see an uptick from here. We have already seen Nifty FY20 earnings growth getting upgraded by 6-7 percentage points post the tax cut to around 22 per cent YoY. Sectors such as corporate banks, low-ticket consumer durables, consumer staples, cement, and pharma should drive the growth. Further progress in terms of resolution of NBFC issues; additional rate cuts by the RBI, along with rate transmission; an improvement in the demand environment; and concrete outcomes on the privatisation of PSUs will provide impetus to earnings and markets over the next six-12 months.
What's your view on shrinking alpha in active funds versus the TRI benchmarks? Have you taken any steps to address it?
Historically, active funds in India have outperformed their benchmarks. For example, on an average, multi-cap funds have outperformed the BSE 200 TRI index by around 200 bps annualised over a 10-year time frame. As the market matures, it is quite natural to expect this outperformance to decline, as has been seen in developed markets like the USA. However, in India, we believe fund managers still have ample opportunities for generating alpha. Equity markets in India have multiple domestic and foreign players and are not dominated by a few large institutional investors. New companies in emerging sectors (example, insurance) keep coming to the market via IPOs and fund managers can participate before they grow in size and become a part of the benchmark.
Over the past one year, active funds have only managed to marginally outperform their benchmarks due to the divergence in performance of the top eight-10 stocks and the broader market. But this is an exception. Going forward, visibility of economic and earnings growth should improving, which will lead to broader market participation. That should normalise the returns of active funds and their outperformance versus their benchmarks.
Internally, we have done some consolidation in our funds and reduced the number of stocks held in our funds. We have also specified a minimum holding for stocks that have a large index weight. We can then focus on generating alpha through other stocks.
Do you think a shift is likely from growth and quality stocks to value stocks?
Globally, as well as in India, growth has performed well while value has underperformed for more than five years now. However, with central banks becoming dovish and reducing rates, we are seeing value stocks starting to perform globally. In India too, in an environment where interest rates are declining, value stocks can appreciate as they offer high earnings yield and dividend yield. Also, as the sentiment starts to improve, value typically does well, as has happened after 2013. Considering that we are at the bottom of the cycle and a recovery seems likely, value stocks could do well from here on.
If we look at sectors, there is a wide dispersion in valuation metrics across sectors and even in the companies within a sector. Sectors such as NBFCs, PSUs (excluding banks) and utilities, pharma, auto, and infrastructure and capital goods are offering good value.
What are the red flags that stop you from buying a stock?
Key red flags include serious corporate-governance issues, high leverage, consistent negative free cash flows, and low ROCE over a business cycle.
What would be your advice to the equity investors who are getting unnerved in the current market?
Markets have underperformed over the past year due to significant volatility. However, if we look at long-term returns, it is evident that investors who remain invested in the market have made a good return even if they had invested at the top. At this time, we are seeing a structural improvement and should see a recovery from here on. Valuations are also not expensive and the risk-reward for equities is fairly balanced, offering an opportunity for investors to make a reasonably good return in the medium to long term.
In such times, it is crucial for investors to be disciplined and focus on proper asset allocation and fund selection. Investors can allocate 50-60 per cent of the corpus to large-cap and multi-cap funds, which can provide stability to the portfolio. It would be prudent for investors to allocate 20-25 per cent of the corpus to mid-cap and small-cap funds from a three- to five-year perspective. Investors can allocate 20-30 per cent of their portfolios to thematic funds focused on consumption, pharma and value.
To their credit, retail investors have been patient and disciplined, as is evident from stable monthly SIP inflows thus far.